Just when everybody thought gold bullion was down and out and embarking on a downward spiral, the shine returned. Even erstwhile gold bug Richard Russell started favoring the Dow stocks over the yellow metal, but more about that later.
Since my last, somewhat upbeat, article on gold bullion and gold stocks about five weeks ago they have come out of hibernation with a vengeance, with gold metal up by 3.8% and gold stocks (as measured by the HUI Gold Bugs Index) by 8.5%.
One of my arguments at the time was that gold stocks, long-standing laggards at that stage, were starting to display relative outperformance against the gold price. The stocks have often in the past anticipated an imminent rise in the metal price and this time round turned out to be no exception.
The chart below illustrates the point, showing the HUI Index in the top section and the same index relative to the gold price in the bottom half.
Gold bullion and gold stocks have a tendency to move off centre stage on occasion, but just as despondency sets in these powerful moves often take place. It is almost as if we need to remind ourselves of the following Spandau Ballet refrain every now and then: “… gold … you’re indestructible, always believe in, because you are gold.”
A strong rise in the gold price at this time of year should not come as a complete surprise as indicated by the graph below showing the average monthly rises/declines since the beginning of 1970.
It is evident in the graph that contrary to the pattern in the S&P 500 Index, May to September are historically quite good months for gold. The fundamental picture for gold is also shaping up quite favorably. Notwithstanding continued sales by some major central banks, production is shrinking year by year, and the declining dollar and rising oil prices provide powerful tailwinds.
Still not sold on the idea of including some of the shiny stuff in you portfolio? How about arguing the case from a diversification point of view? The correlations of the weekly price movements of the gold price with a number of major stock markets from June1992 to July 2007 are given below.
With concerns about the outlook for equities, and especially market breath, deteriorating day by day, gold bullion is perhaps not a bad place to hide from some dark clouds.
Back to Richard Russell’s argument that gold’s outperformance of the Dow Jones Industrial Index may be reversing when viewing the ratio’s long-term trend line”. Well, I am not convinced that we have in fact seen a long-term break-out in favor of equities. Irrespective of some underperformance since the middle of last year, the metal still appears to be cheap relative to stocks when taking a bird’s-eye view of the following chart:
It is important to keep in mind that the relative chart can move higher in one of three ways: as a result of gold increasing faster than equities, gold falling less than equities, or gold rising and equities declining.
Now this is where one can have fun and games with some “pop analysis”. Should the Dow stay exactly where it is, and the ratio moves back to the long-term average, it implies a gold price of approximately $1 920 per ounce (13 717 x 0,14). However, should the ratio overshoot the average and go back to its 1980 peak, bullion will be a cool $11 248 per ounce (13 717 x 0,82)! These levels seem quite absurd from where we stand right now, even for the heftiest of gold bulls, but as a minimum there certainly appears to be very little downside based on the historical ratio.
Although negative market sentiment may affect all asset classes over the very near term, for my money gold bullion and gold stocks might be the winners on a bumpy road ahead over the next few months, especially for investors placing an increasingly stronger focus on capital preservation in future. Corporate action among the gold producers, as a means of boosting reserves, could add the proverbial cherry.
Let’s conclude with Bernard Baruch’s words: “Gold has worked down from Alexander’s time … When something holds good for 2 000 years I do not believe it can be so because of prejudice or mistaken theory.”